The announcement of the Borssele auction results was greeted by the offshore wind industry with a mixture of astonishment, delight and (from competitors) a little concern. DONG had beaten the €100/MWh levillised cost of energy (LCOE) barrier well ahead of schedule!
DONG’s bid secured15 years of SDE+ (the Dutch equivalent of CFD) funding for the project followed by the ability to sell energy at market price for the rest of the project’s life.
Obviously, LCOE and bid prices are two distinct measures that cannot be directly compared. DONG’s bid was actually at €72.7/MWh, which implies an LCOE of about €68/MWh excluding transmission. The Dutch Government has already paid for key elements of project development activity and is taking the risk on the transmission connection for which it will add a (fairly modest) €14/MWh to the costs, giving a total project LCOE of about €82/MWh That is a dramatic decrease from current levels.
So what is behind this headline figure and how have DONG managed to leap ahead in the race to “subsidy-free”?
As explained in my previous blogs, there are six main levers of LCOE –energy production, annual operating cost, total capital cost, project lifespan, cost of finance and timing of capital expenditure. Assuming a “normal” expected life of the project and timing of capital expenditure, our analysis suggests that DONG’s bid is likely to have pulled hard at the other four levers.
The chart below shows how DONG may have been able to make this leap ahead.
Figure 1: Getting to DONG’s LCOE
We start with an estimated range of LCOE for 2020 FID 500MW self-developed sites across different locations in European waters.
Firstly, the natural advantages of the Borssele sites put them close to the lower end of this range for LCOE. The sites are close to shore, have a water depth suitable for monopiles and have good wind conditions.
Transmission costs will be paid separately paid by the Dutch Government. These would add around €14-16/MWh to the LCOE normally for a self-developer (though the Dutch Government is only charging €14/MWh for this). The Dutch Government is also paying for some development activities. Project size is a factor, and by bidding and being successful for both sites, totalling 760MW, DONG should be able to achieve economies of scale, further reducing LCOE.
So our estimate for LCOE at Borssele using only the advantages of site conditions and the Dutch government’s approach to transmission and development costs is €84/MWh. At 8.5% WACC, this would have implied SDE+ / CFD bids at €92/MWh. Of course, this is very much the starting point for all bidders, with an expectation that competition (from the reported 36 bidders) would drive bids lower.
Combining the additional 760MW with existing supplier orders can give DONG an advantage in enabling it and its supply chain to industrialise to lower LCOE.
Through its deep knowledge of the sector DONG probably has higher buying power (even in a pipeline situation) than other bidders. When combined with DONG’s ability to learn lessons and reduce cost faster than the industry average, this will deliver further benefit.
DONG and its turbine supplier may have come up with ways to increase AEP, especially rotor size, but also reliability, availability, overrating in some conditions and reduced losses.
DONG’s finance providers may view that any investments are relatively low risk due to the financial attractiveness of the DONG organisation, as demonstrated by the recently successful IPO. If so, a lower WACC (weighted average costs of capital) would be available on the project (even after allowing for pipeline WACC reduction).
As shown, by pulling hard on most of the available levers, DONG has been able to offer the Dutch government a stunningly low price at the Borssele sites. That should be welcomed by electricity consumers, governments and ultimately the industry as a whole.
Now that DONG has set this new benchmark, they and other developers will have to examine their supply chain, procurement strategy, finance structures, site characteristics and technology to ensure they match (or beat) this price level for future projects. Governments will also need to examine policies that encourage equal levels of competitiveness, offer project clarity and enable the benefits of industrialisation and the other approaches used to be delivered by multiple players.
If you’d like to know more about how we can help you model cost impacts or develop your understanding of offshore cost trends, email Giles Hundleby.